The American economy may be “fairly bad” for the next six to nine months, says Goldman Sachs, and that may be the best-case scenario.  The other option is “very bad.”  GS says that the chances of another outright recession are still low but cannot be discounted:

“We see two main scenarios,” analysts led by Jan Hatzius, the New York-based chief U.S. economist at the company, wrote in an e-mail to clients. “A fairly bad one in which the economy grows at a 1 1/2 percent to 2 percent rate through the middle of next year and the unemployment rate rises moderately to 10 percent, and a very bad one in which the economy returns to an outright recession.”

The Federal Reserve will probably move to spur growth as soon as its next meeting on Nov. 2-3, Hatzius said. Expectations for central bank action have already led to lower interest rates, higher stock prices and a weaker dollar, according to Goldman, one of the 18 primary dealers that are required to bid at government debt sales.

Fed Chairman Ben S. Bernanke and his fellow policy makers are debating whether to increase Treasury purchases to spur the U.S. economy by keeping borrowing costs low. U.S. five-year yields dropped to a record 1.1755 percent today amid signs the recovery is losing momentum.

The “fairly bad” outlook for slow growth and rising unemployment without a recession will probably be the one that occurs, the e-mail said.

The government will release its estimation of Q3 GDP growth at the end of the month (October 29th), which will give an indication of where we’re heading.  However, the determinative factors are all in front of us.  Congress has to take action on the scheduled tax hikes to determine whether to postpone them another year or two, and which tax bracket rates to extend, if any.  Bloomberg doesn’t report whether GS factored in tax rate changes into its formula, or whether it assumed no changes would be made at all.  It’s more likely that they simply kept their eyes on the massive uncertainties created by the Obama administration and Congress and just assumed that would continue into next year.

Clearly, though, GS doesn’t see any hope of solid growth in the next three quarters, and neither does anyone outside the West Wing.  Extending middle-class tax rates alone won’t produce any upward momentum; it will just continue the status quo.  Extending the top rates for at least a year or two might actually have a positive impact, as those with capital to invest will have a short window in which to do it and claim some income at lower tax rates.  Obama has insisted that he will oppose those extensions, but has yet to threaten a veto if Congress defies him on the issue.

In fact, it’s difficult to understand why Obama didn’t agree to a one-year, across-the-board extension.  It would have kicked the can down the road only another 12 months, but would have relieved the short-term uncertainty that plagues the capital markets today.  It would have given Democrats a boost at the polls in the midterms with moderates and independents, and probably created a real stimulus to the economy, although likely small in scale.  For the kind of growth needed to restore employment to its previous levels, we need long-term certainty on tax rates and regulation, but it might have been enough for Democrats to salvage a few marginal seats in the midterms this November.

If Congress hikes taxes on the higher bracket through deliberate inaction, though, I’d expect the second scenario to become a lot more likely, as Peter Ferrara argues in his upcoming Encounter Broadside treatise, President Obama’s Tax Piracy.